Withholding tax obligation applies on payments to non-residents only if there is income chargeable to tax in India

The Special Bench of the Tribunal, departing from the Karnataka High Court’s decision in the case of Samsung Electronics, rules that withholding tax obligation on payer applies on payments to nonresidents only if there is income chargeable to tax in India. Further obtaining CA’s certificate is an alternative procedure for lower or nil withholding cases.

The Special Bench of the Income Tax Appellate Tribunal, Chennai (SB), in the case of ITO Vs. Prasad Production Ltd. (ITA No. 663/ Mds/2003) has held that withholding tax obligation on payer under Section 195 of the Income-tax Act, 1961 (the Act) applies only if the payments to non-residents are chargeable to tax in India. Further, the payer has a first right to decide whether a particular payment bears any income character or not.

The SB chose not to follow the Karnataka High Court decision in the case of CIT v. Samsung Electronics Co Ltd and others [2009] 185 Taxman 313 (KAR) and followed various decisions of Supreme Court, High Courts and Mumbai SB decision in the case of Mahindra and Mahindra Ltd. Vs. DCIT [2009] 313 ITR 263 (Mum) (SB). The SB clarified that the Supreme Court in Transmission Corporation of A.P. Ltd. and Ors. Vs. CIT [1999] 239 ITR 587 (SC) dealt with tax deduction in a case where fraction of income stood embedded in the payments to nonresident and thereby it did not apply to cases where no part of payment has any character of income.

The SB, based on various Central Board of Direct Taxes (CBDT) circulars, held that obtaining a CA’s certificate is an alternative procedure for nil or lower withholding certificate cases.

Facts of the case

• The Taxpayer was awarded a contract by the Tourism Department of the Government of Andhra Pradesh to establish IMAX Theatre at Hyderabad. The Taxpayer entered into an agreement with a Canadian company for purchase of equipment, maintenance and installation. As per the agreement, the consideration was USD 1,365,000 for the purchase of system and USD 950,000 for fees for technology transfer. During the year under consideration, the taxpayer remitted USD 902,500 to Canadian company without deducting tax at source.
• The AO observed that the payment made by the Taxpayer were for the provision of a variety of services to be provided by the personnel of the Canadian company which included installation charges, testing and training for projectionists. Therefore, according to him the amount remitted by the taxpayer was for provision of technical services by IMAX which falls under section 9( 1)(vii) of the Act. The AO after relying on the decision of the Supreme Court in the case of Transmission Corporation of AP Ltd. held that since the taxpayer did not obtain any order under section 195(2) or 195(3) or 197 of the Act, the taxpayer was liable to deduct tax under section 195 of the Act on the gross sum remitted by the taxpayer. Accordingly, the AO initiated proceedings against taxpayer under section 201(1) and 201(1A) of the Act.
• The Commissioner of Income-tax (Appeals) [CIT(A)] held that since the sum paid represents part of the sale consideration for the equipment, they were not chargeable to tax in India. Further, the decision in the case of Transmission Corporation was not applicable when the entire sum not chargeable to tax. Accordingly, the order passed by the AO under section 201(1) and 20 1( 1A) of the Act was cancelled.

Issue before the SB

• Is it obligatory for the Taxpayer to deduct tax at source on the entire payment if it fails to make an application to the AO for deduction of tax at a lower or nil rate of tax under section 195(2) of the Act in light of the decision of the Supreme Court in Transmission Corporation of AP Ltd.?

Tax Department’s contentions

• The Tax Department relied on the decisions of the Supreme Court in the case of Transmission Corporation and CIT v. Eli Lilly and Co. India (P) Ltd [2009] 312 ITR 225 (SC) to contend that the deduction of tax is tentative only and is subject to the assessment in the case of the deductee.
• According to the Tax Department, the payer has no discretion to determine whether a sum payable to non-residents is chargeable to tax or not else section 195 of the Act will become totally inoperative. Further, for no withholding or withholding at lower rate, a taxpayer will need to compulsory approach the Tax Authorities 195(2) / (3) or Section 197 of the Act.
• The Tax Department also argued that the SB is bound to follow aforesaid principles promulgated by the Karnataka High Court in Samsung Electronics Co Ltd (Supra) pursuant to Article 141 of the Constitution of India being a decision of superior judicial authority.

Key contentions of Taxpayer and Interveners

• The Taxpayer referred to section 4 and section 5 of the Act and argued that the tax is required to be deducted from payments to non­residents only if the income was chargeable to tax under the provisions of the Act read with an applicable Tax Treaty. The liability of the deductor and deductee cannot be different. Therefore, the Tax Authorities cannot proceed on a notional basis against the deductor. Reliance was placed on the Supreme Court decision in Eily Lily, Vijay Ship Breaking and plethora of other judicial precedents to support this view.
• The CBDT Circular No. 759 dated 18 November 1997 gave an option to the deductor to furnish an undertaking to the RBI to make remittance without obtaining a No Objection Certificate from the Tax Authority and therefore the Department had themselves dispensed with the requirement of approaching the Tax Authorities under Section 195 of the Act. Though the circular 759 has been subsequently withdrawn, the principle enumerated therein remains. Further, the subsequent circular no. 4 also entrusted the task of determining the tax ability in the hands of CAs as an alternative to the procedure prescribed for obtaining a lower or nil withholding certificate.
• The decision of the Supreme Court in Transmission Corporation was rendered much prior to the Circulars of the CBDT and therefore the observation of the Court even if construed otherwise cannot be made applicable to current situations by picking out a word or sentence from the decision divorced of the context of the questions under consideration. Further, the said decision merely dealt with tax deduction with respect to income chargeable to tax. The Supreme Court never went into deduction on gross amounts or consequences of non-deduction. To that extent, the Karnataka High Court has misinterpreted the decision of the Supreme Court in the case of Transmission Corporation.
• The word ‘may’ in Section 195 suggests that it is not obligatory on the part of the deductor to undergo the procedure under Section 195(2) of the Act.
• Apart from not considering appropriately the provisions of the law, the decision of the Karnataka High Court is contrary to various decisions of the Supreme Court  (See Noe-1)  and High Courts (See Note-2 below) including the Karnataka High Court itself (See Note-3 below). It also did not consider the alternate CA certificate procedure laid down in CBDT Circulars. Hence, the Samsung ruling should not be followed as it is rendered ‘per incuriam’ (latin for through inadvertence) and several judicial principles and cases for not following a binding precedents in such case were cited.

The Ruling by the SB

The Supreme Court’s ruling in the case of Transmission Corporation and section 195(1) of the Act

• The SB observed that the crucial expression under section 195 of the Act is “any other sum chargeable under the provisions of this Act”. This expression has been explained by the Supreme Court in the case of Transmission Corporation to mean even sums which are hidden or otherwise embedded therein.
• The SB observed that if Transmission Corporation’s decision is to be properly construed and understood, it would mean that the person making payment to the non resident would be liable to deduct tax only when the payment so made is chargeable to tax under the Act. Impliedly, if the payment is not chargeable to tax under the Act, the payer would not be liable to deduct tax at source. This aspect has also been clarified by the Supreme Court in the case of Eli Lilly & Co.
• It was laid down by the Supreme Court in Transmission Corporation that withholding tax provisions not only applies to the amount paid which bears ‘income’ character (Such as Salaries, dividends, interest on securities) but also to gross sums, the whole of which may not be income or profits of the recipient (Such as payment to contractors and sub contractors and payment of insurance commission). Thus, even if a fraction of income is embedded in the total payment, the withholding tax provisions would apply. Conversely, if the payer has a bona fide belief that no part of the payment has an income character, withholding tax provisions do not apply. The Transmission Corporation applies only in two situations viz. where the entire payment has an income character and when part of the payment has an income character.

The payer can determine tax liability of payee for the purpose of withholding of tax

• There is no basis to contend that the payer cannot determine the tax liability of payee with respect to the payments he is making to the payee. Section 195(2) of the Act itself permits the payer to consider if the whole of such sum is not chargeable to tax. This clearly indicates that it is payer who is the first person to decide whether the payment he is making to the payee bears any character of income.
• If the tax department is of the view that the payer ought to have deducted at source then it may recourse to the provisions of Section 201(1) of the Act to protect its interest. However, withholding tax is a tentative exercise, ultimately to be decided in payee’s assessment. The Delhi High Court decision in the case of Van Oord ACZ India (P) Ltd. v. CIT [2010-TIOL-187-HC-DEL-IT] has been followed.
• The SB also observed that under section 195(2) of the Act the payer applies to the AO for deduction of tax at lower rate whereas under section 195(3) the payee makes an application to the AO to receive the payment without any deduction of tax. The reason for such difference is that when the payer has a bonafide belief that no part of the payment bears income character, section 195(1) of the Act itself would be inapplicable and hence the payer need not approach AO under section 195(2) of the Act for nil deduction ertificate.

Note:-

1. CIT Vs. Eli Lilly & Co.(India). Pvt. Ltd. [2009] 312 ITR 225 (SC) Vijay Ship Breaking Corporation Vs. CIT [2008] 314 ITR309 CIT Vs. Wesman Engg. Co. Pvt. Ltd. [1991] 188 ITR 327 (SC) Transmission Corporation of A.P. Ltd. vs. CIT [1999] 239 ITR 587 (SC)
2. 7 Porbandar State Bank vs. CIT [1949] 18 ITR 134 (Bom),  CIT v. Cooper Eng Ltd. [1968] 68 IT 457 (Born), Czechoslovak Ocean Shipping International Joint Stock Company v. ITO [1971] 81 ITR 162 (Cal), CIT v. Superintending Engineer, Upper Sileru [1985] 152 ITR 753 (AP) CIT v. State-Bank .of India [2008] 226 CTR 310 (Raj)
3. Hyderabad Industries Vs. ITO [1991] 188 ITR 749 (Kar), Jindal Thermal Power Co. Ltd. Vs. DCIT [2009] 225 CTR 220 (Kar) ACIT Vs. Motor Industries Co. [2001] 249 ITR 141 (Kar), CIT Vs. Infosys Technologies Ltd. [2006] 293 ITR 146 (Kar)